Why Joe McNay Likes Tech, Drug, Online Ed, and Solar

By

Sandra Ward

September 27, 2014

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If there's a way to profit from new technologies and business developments, chances are good that Joe McNay, founder and chief investment officer of Boston-based Essex Investment Management, will have found the angle long before anyone else. A dedicated practitioner of growth investing, McNay, 80, has spent more than a half-century trend-spotting and, as a result, built an enviable track record. It is always instructive, and fun, to check in with the hail-fellow-well-met McNay.

Barron's: We last spoke a few years ago, when the Nasdaq had just passed 3000, and here we are closing in on 5000. What's your thinking right now about the stock market?

McNay: The Federal Reserve appears to be leaving interest rates where they are, and that's positive. Growth may be slow in the U.S., but it is positive on a relative basis and outstanding when compared with the European countries. Even China is slowing down. So external funds are flowing into the U.S., and both stocks and bonds have been acting very positively, even though our government has reduced its purchasing of government bonds. Despite the strengthening in the U.S. stock market, the public has kept large amounts of money in bonds or in cash on the sidelines. This sets up the possibility of a much stronger market if China and Europe become more stimulative, which I think they will, and that will increase employment and boost exports and drive their currencies down, and it will be quite positive overall for the U.S.

The expansion continues?

The expansion is likely to continue. The dollar is getting stronger now, and that's both positive and negative. The negative is we will start importing more because our currency is so good compared with foreigners'. On the other hand, our economy is pretty strong on a relative basis, and that's good. Also, our president is aware that public opinion of him is very low and so he probably will be more likely to do things that would start to improve his image, and that means spending on infrastructure projects—bridges and roads—and taking a more aggressive stance.

"The market is no longer dirt cheap, but it's also not overbought. It has plenty of room to move higher, on a historical basis." -- Joe McNay
Photo: Jason Grow for Barron's

Is it getting harder to find stock opportunities?

The market is no longer dirt cheap, but it is also not overbought. It is priced more in the medium to slightly high-end range, but it has got plenty of room to move higher on a historical basis. The Standard & Poor's 500 is trading at 18 times earnings, but in the past has traded as high as 25 times earnings. I'm not saying it will get there, just pointing out it is in a position to move up some. The single most negative aspect of the market is that we have the highest profit margins in the history of the U.S. Is that sustainable? To some degree it is, because part of that is based on technology and the success we have had in reducing costs and being able to develop products more cheaply.

So you take issue with the argument that profit margins will at some point revert to the mean?

They could decline, but not as far as they would have formerly. On average, we will have higher profit margins.

Any other reasons to remain bullish?

Corporations are cash-rich. They are buying back stock or acquiring other companies. Dividends are increasing at a faster rate. One of my themes is the aging population, and retirees want more income from their investments. Even though interest rates have improved some, they are still near the lowest levels of our lives.

Do you see rates rising anytime soon?

In the short term, foreigners want to own the U.S. currency, so they are buying U.S. bonds because that's a better return than nothing, and so at the moment I don't see it happening. It will happen not because of the government, but because of the public market: If the stock market continues to outperform, people will want to get in and they will start selling their bonds, in particular their short and intermediate bonds, and will put their money in equities.

Let's turn to your investing themes, the aging population, for one.

The biggest area for us when it comes to the aging-population theme is the medical area. There will be more consumption of pharmaceuticals, more utilization of hospitals, and more medical care. Biotechnology stocks are one way we invest along this theme.

Any names in particular?

The ones I like the most are up a lot, and while I still hold them, I'm not buying them at current levels, and that includes
Gilead Sciences
[ticker: GILD],
Celgene
[CELG], and
Biogen Idec
[BIIB]. But one of our more aggressive investments in this area is
Actavis
[ACT], which sells both generics and branded products and over-the-counter drugs, and is one of the largest drug sellers in the world after buying Forest Laboratories earlier this year. I own it, based on the increasing numbers of people who will be getting medical care and pharmaceuticals because of the Affordable Care Act. We also own some small companies that are going through the Food and Drug Administration approval process. The big moves often come in the more speculative companies. One example would be
Aerie Pharmaceuticals
[AERI], which has a drug to treat glaucoma in Phase 3 clinical trials, and if it gets approval, it would be a big deal because it would reduce the number of medications taken numerous times a day to just one dose of eyedrops a day. There has not been a new drug to treat glaucoma in many years.

Education. A good education at the lowest price is available over the Internet. A company called
2U
[TWOU] is virtually No. 1 in the world in online education. It operates only with leading universities. You have to apply to the university and get accepted before being allowed to take courses through 2U. You get to know your professors. Classes meet regularly. But you don't have to move to the college and take a room and live there, so it costs half as much to get a college or graduate degree.

McNay's Picks

Recent

Company

Ticker

Price

Actavis

ACT

$244.53

Aerie Pharma

AERI

19.42

2U

TWOU

15.21

Palo Alto Networks

PANW

96.30

Integrated Device Tech

IDTI

15.47

First Solar

FSLR

67.20

Canadian Solar

CSIQ

37.89

SunEdison

SUNE

19.42

SunPower

SPWR

35.91

Source: Bloomberg

This suggests you don't think tuitions are going to drop anytime soon.

Tuitions are going to stay up. 2U offers courses at the same price as the university, but with no other costs. This model will drive smaller community colleges out of business. Education is shifting to the Internet, where you can get a high-quality education from outstanding universities. One of the biggest U.S. problems is students leaving college saddled with debt. This eliminates that, to a large degree.

What are the risks to this?

In the short term, the negative is that 2U came public in March, and the lockup period for insiders expired [last week], and the stock started selling off leading up to that. Also, 2U will lose money initially, as it spends money to sign up students, but after two years, it expects to be profitable. Eventually, it will get 65% or 70% of the income that the student pays to take the course. The university makes money from this arrangement, as well. It doesn't have to care for the student from the standpoint of providing housing and food and security, and so it can increase its enrollment substantially without increasing any costs.

How about another pick?

Cloud computing is an area I like. Corporate managements are running their companies over the Internet, and it also encompasses social media and all that is going on with communications and information technology. It's a very big area, and what's in big demand now is securing the cloud, as witnessed by the security breaches at
Home Depot
[HD] and
Target
[TGT].
Palo Alto Networks
[PANW] would be our king of the castle there.

What sets them apart?

Palo Alto is taking market share.
Checkpoint Systems
[CKP], the former leader in this area, is gradually losing share to Palo Alto. It's now a $7.5 billion market-cap company and near its all-time high of $100, but it should move higher as its business grows and it becomes more profitable. Sales in the past four quarters have increased each quarter by more than 45%, and earnings will triple in the next few years.

Any other tech companies?

Apple is out with its new products, and that will drive demand for a few companies that supply it.
Integrated Device Technology
[IDTI] is in a very good position, as it makes chips for smartphones and computers and is rumored to be supplying a wireless charging integrated circuit for the Apple Watch. It is the new supplier leader in the charging area.

Any other areas of interest?

Clean technology is one of our investment themes, and the solar industry is a favorite. We love
First Solar
[FSLR],
Canadian Solar
[CSIQ],
SunEdison
[SUNE], and
SunPower
[SPWR]. The industry went from being massively oversupplied to more balanced and even to a slight shortage of product. They've actually lowered the cost of their products tremendously, and the products are becoming more efficient, and that has led to dynamic growth. The government is still helping to finance the industry with a tax credit of 30%. There will be another major move of decreasing costs and increasing capabilities. First Solar will be one of the leaders in that.

Aren't the government subsidies going away?

They will be coming to an end in 2016, encouraging anybody thinking of making a move to solar to hurry up and do it while there is still good government financing. But there's a lot of private financing, and it is growing.

Do you still like gold?

Gold is making its bottom, and this is a time to accumulate it gradually.

Why?

All the foreign countries that are in trouble are going to need to stimulate their economies, and when they do, they will do it by printing money. That will be good for gold. Also, China wants to be the world's reserve currency and is the biggest producer of gold and the biggest buyer of gold in the world. It's not a favored investment in the U.S. because we're in a better position economically than we were.

Why Joe McNay Likes Tech, Drug, Online Ed, and Solar

If there's a way to profit from new technologies and business developments, chances are good that Joe McNay, founder and chief investment officer of Boston-based Essex Investment Management, will have found the angle long before anyone else.

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